Stock Dividends and Splits

On occasion companies choose to conserve their useable cash by paying their shareholders with stock dividends, which, as the name implies, are dividends that are distributed in the form of company stock. The organization recapitalizes its earnings and issues new shares, which has no effect on its total assets and liabilities. Stock dividends are usually expressed as a percentage of the number of shares that the company has outstanding. For example, if a company that has 100,000 shares of outstanding stock issues a 10 percent stock dividend, the total number of shares outstanding would be increased to 110,000.

Shareholders who receive a stock dividend in this manner acquire more shares of the company's stock, but the shareholder's wealth in the company is not increased. Because the company's assets and liabilities remain the same, the price of the stock must necessarily decline to account for the dilution brought on by the creation of more shares. This situation can be understood by using a slice of pie. The shareholder can divide his or her slice into two, three, four or twenty pieces; but no matter how many ways it's cut, the overall size remains the same. After a stock dividend is issued, shareholders have more shares, but their proportionate ownership interest in the company remains the same, and the market price of the individual shares declines proportionately.

Like the stock dividend, a stock split is a proportionate increase in the number of outstanding shares that doesn't affect the issuing company's assets, liabilities, equity or earnings. As a matter of fact, the only difference between the two is in the area of accounting. A stock dividend of greater than 25 percent is recorded as a stock split. A 100 percent stock dividend is known as a two-for-one stock split. A company might decide to split its stock because the price is too high; with a lower price, the stock becomes more marketable. Let's take a simplified look at what happens when a two-for-one stock split is declared.

As an example, a company has 1 million shares of stock outstanding with a price of $50 per share. After the two-for-one split, the company will have 2 million shares outstanding, and the stock will trade at $25 per share. Additionally, a shareholder who owns 100 shares before the split would have 200 shares afterwards with a value of approximately $25 per share. There is no net change, either in the company's bottom line or the actual value of the shareholder's investment.

Conversely, companies may also announce reverse stock splits, which reduce the number of outstanding shares (again without affecting the company's assets or earnings). When a corporation's stock has fallen in price, a reverse split raises the price to a more desirable level. For example, a stock trading at $1 per share would be raised to $10 with a l-for-10 reverse split. Using this split, the number of shares outstanding would be reduced by ten times. Each shareholder would have only one-tenth as many shares as previously, but each share would be worth ten times as much.